BOJ Battle: The Empire Strikes Back

For a year, the Bank of Japan’s new leadership has drawn surprisingly little flack while executing a self-proclaimed aggressive “regime change,” breaking from a decade of more cautious policymaking.

Now the repudiated old guard is striking back, publicly ringing alarm bells about the lurking dangers of a massive money-printing program, even while many economists say recent signs of slowdown call for a bigger dose of short-term stimulus.

Kunio Okina, a long-time BOJ official widely considered Japan’s most influential monetary economist in the 1990s and 2000s, delivered a speech Friday dissecting what he called “the Achilles’ heel of Abenomics,” a reference to the economic revival plan of Prime Minister Shinzo Abe. Abenomics relies heavily on turbocharging the restrained monetary policy long advocated by Mr. Okina and his disciples.

In the speech, Mr. Okina warned about longer-term risks from the policies launched in April 2013 by Mr. Abe’s handpicked Bank of Japan governor, Haruhiko Kuroda, shortly after he replaced Mr. Okina’s long-time associate, Masaaki Shirakawa, as Japan’s top central banker.

At one point in the speech, Mr. Okina compared current Japanese economic policy to the recent disastrous experience of Zimbabwe, which was plagued by rampant inflation and colossal government debt.

The lecture, delivered in the southern region of Kyushu on the first anniversary of Mr. Kuroda launching his monetary “bazooka,” followed a series of critical comments that Mr. Okina, now an economics professor at Kyoto University, has made in the Japanese press in recent months.

In a December interview with the Asahi Shimbun, Mr. Okina criticized Mr. Kuroda for “manipulating information” and for “promoting phony medicine as real.” He talked of the dangers of “a surge in long-term interest rates,” and said: “I wonder how a soft landing will be possible.”

Mr. Okina’s campaign won’t affect Japanese monetary policy in the short term. Mr. Kuroda has solid control over the BOJ policy board, and strong backing from Mr. Abe and his allies. The Kuroda bazooka is generally seen as the most effective part of Abenomics to date. Fiscal policy has been mixed, with a sales tax hike dampening the impact of a big new public works spending push. Promised longer-term structural reforms — from deregulation to free trade — have progressed slowly.

But Mr. Okina’s increasingly prominent critique does open a new phase of public debate over Abenomics, which has largely gone unchallenged amid broad signs of quick success, from an apparent end to a decade of deflation, to a sharp rise in stock prices and drop in unemployment.

Mr. Okina’s views did more to shape the immediate path taken by the BOJ, where he ran the Institute of Monetary and Economic Studies. Mr. Iwata became the BOJ’s leading outspoken outside critic. Then, as part of the last year’s BOJ “regime change,” Mr. Abe tapped Mr. Iwata to serve as BOJ deputy governor under Mr. Kuroda.

Now on the outside, Mr. Okina argues any short-term gain from Abenomics risks being offset by long-term pain.

Either Abenomics sputters out and fails to end Japan’s long slump. Or it succeeds to the point where the BOJ has to formulate an “exit policy” from its current aggressive easing, along the lines of the U.S. Federal Reserve’s current “tapering.” And that’s when Mr. Okina foresees a dangerous day of reckoning.

Here’s why. The main ammunition for the Kuroda bazooka is the large-scale purchase of Japanese Government Bonds. The BOJ injects money into the economy by buying JGBs from the banks that hold them. That pushes up the price — and drives down the interest rate — on the bonds. That makes it dirt cheap for the Japanese government to keep borrowing, which is convenient for Mr. Abe, since Japan’s government is the most indebted on earth, except, perhaps, for Zimbabwe.

What happens if and when Mr. Kuroda succeeds in hitting his target of 2% inflation? At that point, he has a choice, Mr. Okina said in his speech. The BOJ could curb bond buying to steer interest rates higher. But that would raise the cost to the government of its outsized borrowing, “severely aggravating government debt problems.” It would also, he said, wreak havoc on the BOJ’s own balance sheet, since the price of the JGBs in its portfolio would fall.

Or Mr. Kuroda can choose to keep interest rates low by continuing his big bond buys, and then “it will be impossible to halt inflation overshooting,” Mr. Okina said. In other words, Japan would have simply replaced a deflation problem with inflation.

One way out of the bind is for Mr. Abe to pare debt, with more tax increases or spending cuts, but Mr. Okina calls that a “fairly dangerous” path requiring “major pain and great economic and political risk.”

Kuroda allies — many trained by Mr. Okina — privately acknowledge the legitimacy of these concerns. But they respond that it’s way too soon to worry about the exit policy, with the economic recovery showing signs of fragility, and more forecasters betting that Mr. Kuroda will fall well short of his 2%-inflation-in-two-years pledge than overshoot it.

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Japan Real Time is a newsy, concise guide to what works, what doesn’t and why in the one-time poster child for Asian development, as it struggles to keep pace with faster-growing neighbors while competing with Europe for Michelin-rated restaurants. Drawing on the expertise of The Wall Street Journal and Dow Jones Newswires, the site provides an inside track on business, politics and lifestyle in Japan as it comes to terms with being overtaken by China as the world’s second-biggest economy. You can contact the editors at japanrealtime@wsj.com